The Correct Train For You

As we discussed last week, investing during your retirement years is drastically different than investing during your ‘working’ years when your spending needs were supported by income from work.

It all starts with knowing the rate of return you must earn in order to have your retirement savings provide the lifestyle sustaining income you want without running out of money.

Once you’ve calculated the rate of return you must earn, the next question that we ask in developing The Relaxing Retirement Formula™ is where do you position your investments to produce that long term rate of return that you need while experiencing less volatility and paying less taxes to the government?

To help you determine the correct answer for yourself, there are four Principles and Guidelines I’d recommend for you.

Last week, we tackled the first one. Today, let’s tackle #2.

Which Train?

If you took an objective step back and observed all of the advertisements for different investments, and you listened to all the arguments on money related shows like CNBC’s Squawk Box, or on Jim Cramer’s Mad Money Show, you’ll notice that there’s a mountain of conflicting recommendations out there.

Why do you think this is?

The reason is that almost all investments have merit for somebody. Because of this, an argument can be made in favor of any investment.

The question you need to ask concerns the appropriateness of a specific investment for YOU given your unique circumstances and priorities.

To help you determine which investments are appropriate for you, and how much of them are appropriate, I recommend the analogy of “trains”.

There are some trains that move very slowly. And, there are others that move much faster.

In the investment world, here’s an example of average historical rates of return for various asset classes (trains):

Money Markets and CDs: 2-3%

Government Bonds: 4-6%

Fixed Annuities: 3-6%

Corporate Bonds: 5-7%

Large Cap Stocks: 9%

Mid Cap Stocks: 10%

Small Cap Stocks: 11%

Each of these categories has subsections which might include value vs. growth stocks, foreign and emerging markets, high vs. low quality, and various sectors including health care, energy, and consumer products, etc.

As you can see, some investments move more slowly and others move much faster. The further down the list you go, the higher the historical rate of return each has produced.

However, along with that higher return comes much higher volatility and much higher likelihood that you won’t achieve those returns in a given year.

Key words: “in a given year”.

How Much of Each?

Going back to the rate of return you “need” to earn, let’s assume for a minute that you need to earn a 7% overall rate of return on your money in order to make your Retirement Blueprint™ work, i.e. to have your investments remain intact year after year while still providing you with the lifestyle sustaining income that you want.

Can you afford to have all of our money in money markets and CDs earning 2-3%?

Certainly not.

Money markets and CDs have no volatility, but they also don’t provide you with a high enough return if you need to earn 7% to make your numbers work. Alone, they will not get the job done for you.

Conversely, if you only need a 5% rate of return, do you need to have all your money in small cap stocks?

Certainly not again! Why subject yourself to the higher level of volatility if you don’t want or “need” to.

The question isn’t which is better. The question is “how much of your money do you need to subject to each asset category in order to produce the overall rate of return you need to earn while subjecting you to the appropriate level of volatility”?

Please take a moment to go back and read that sentence again.

To accomplish this, you’re going to ask different styles of investments to do different things.

Because of this, you can expect them to behave differently. The key word is to “expect” it and not be surprised when it does.

This leads us to the 3rd Principle and Guideline which we’ll tackle next week.

I will tell you ahead of time that Principle #3 is the one that allows you to sleep at night even during large amounts of market turbulence like we all experienced in 2008-2009.